Don't Let Your Portfolio Run Out of Gas!

Name: Joseph Ponzio Company: Opportunites in Options

Years Trading: 19 Favorite Movie: From Russia with Love

It’s becoming clear, as the global economy shifts and the dollar devaluation continues, that the skyrocketing prices of commodities won’t be cooling off anytime soon. The Federal Reserves decisions to cut interest rates in order to bail out the stock market have sent the dollar into a downward spiral, and, as a result, the demand has soared for tangible assets valued in dollars. Although significant movements have occurred throughout all the commodity sectors, we anticipate that the seasonal trending markets should increase more dramatically than years past. The Unleaded Gasoline market which is just weeks away from the reformulation process historically increases in price during the summer months because of peak demand during ‘driving season.’ The decline of the Dollar, Unleaded Gasoline reformulation and the correlation to Oil pricing are just a few reasons investors are anticipating this year’s spike in price is going to be very significant compared to years past.

Gasoline Reformulation
A major factor influencing gasoline prices this time of year is the reformulation of winter grade gasoline into the more eco-friendly summer grade. Due to the unhealthy air pollution levels that plague virtually every major city in the United States, specialized blends were mandated for 14 metropolitan areas to achieve the air quality standards set by the Environmental Protection Agency. The EPA requires that certain volatile chemicals in gas sold between May 1 and Sept. 15 are removed so they can’t evaporate in the heat and react with pollutants to create ozone, a main component of smog. In the winter, gasoline is formulated with a higher evaporative tendency in order to facilitate the starting of vehicles in colder weather and to reduce the expense of production. Therefore, in the summer months, the evaporative nature of gasoline must be reduced. This requires refiners to remove additional components from their gasoline blends, leading to fewer gallons available from each barrel of oil and higher cost of production. Delivery requirements to wholesale outlets for the summer blend fuels begin May 1st and are to be sold at retail by June 1st. This timing coincides with low consumer demand and presents the best opportunity for refiners to temporarily shut down operations and conduct routine maintenance.

Consequently, the supply of winter grade gasoline can fall behind consumer demand during the months leading up to summer, causing the retail price of gasoline to increase while stocks of the more expensive summer grade gasoline are built up. Since 2000 the transition between winter and summer grade gasoline has had a significant effect on prices and this year is another tremendous opportunity to be involved. The duration and the severity of the spring price increase have varied over the past seven years, but prices have continued to increase by an average of 29 cents each spring. This evidence is confirmed when viewing the chart. The idea is to take positions before May 1st, when wholesale gasoline is required for delivery, and by this time, the reformulation process will be complete. The market is trending higher in the long term and we believe it is on the threshold, this spring, of the largest spike we’ve witnessed. Get your positions in your portfolio and enjoy the ride.

Oil’s Influence
According to the AAA organization, last month’s retail gas increase of 27 cents to $3.23 per gallon is the highest national retail average ever. Because many investors regard oil and other commodities as a hedge against inflation, prices have surged in the energy sector. Over the last year, Oil prices have increased from $59 a barrel to as high as $112 a barrel, up 84% annually. Even though gasoline prices have hit record levels recently, they have only increased by 32% during the same period. Oil prices have traded comfortably over $100 a barrel over the last few weeks, as high as $112. The disparity between the increases in price is notable, especially when you consider gasoline consists of 52% Crude Oil. While most markets have characteristics and patterns, Oil tends to be sensitive and react violently to the slightest piece of fundamental information, and there is a lot out there to influence the direction of the market higher. There is still a war going on in Iraq and geopolitical tensions continue to increase, shipments in the Middle East could be disrupted at any moment. The Straight of Hurmuz, which 30% of the world’s oil supply travels through, is controlled by Iran. It’s scary to consider what could happen if tensions aren’t resolved soon. In tandem with the surging price of oil, unleaded gasoline prices should continue to soar!

Dollar Devaluation
Another major influence on Unleaded Gasoline is the value of the Dollar. This market is valued in Dollars! The U.S. Fed policies enacted over the last 6 months have sent the Dollar to its lowest levels on record. Recent bank and financial stress have threatened the economy and the Fed has been forced to add liquidity, by slashing interest rates and infusing massive amounts of capitol. Rates have declined by 3% to 2.25%. Under normal circumstances rate cuts result in currency devaluation which will help to balance the economy. In this case, the dollar has been the catalyst for the explosion in commodity prices, which we will continue to feel the effects of for some time.

The Trade
September Unleaded Gasoline – Bull Call Spread

Establishing a bull call spread involves the purchase of a call option on a particular market, while simultaneously writing a call option on the underlying market with the same expiration month, at a higher strike price. The buy and the sell of this spread are both opening transactions, and are always the same number of contracts. The bull call spread, as any spread, should be executed as a “unit” in one single transaction, not as separate buy and sell transactions. A bid and offer for the whole package shall be requested through your brokerage firm or from an exchange where the options are traded.

September Unleaded Gas Futures – $2.67

Buy September $2.90 Call
Sell September $3.00 Call

Pay 200-250 points ($840-$1,050)

Max Risk – The amount you pay for the spread ($840-$1,050) plus fees.

Max Reward – The most this spread could be worth would be $4,200. The amount that you pay for the spread, minus $4,200, would be your profit potential.

It is apparent that my view on Unleaded Gasoline is extremely bullish. We believe this years spike in price should result in prices above $3.00. By utilizing the bull call spread strategy we are close to the money, which is exciting. The Unleaded Gas futures are trading around $2.67 in the September contract. We feel purchasing the September options gives us the opportunity to sit in this market throughout the summer and take advantage of the seasonal increase we are so confident about witnessing. By purchasing this spread we have a predefined risk. It is always important to consider a worse case scenario when making your trading decisions. We can not loose more than we pay for the position. If the market does not make a big spike, we will utilize the proper money management skills to salvage the value we have left on the positions, rather than allowing them to expire worthless.

Questions or Comments:
Joseph Ponzio
Sr. Commodity Specialist
Opportunities in Options
(800) 900-8000 .xt 236
JPonzio@OIOonline.com

Futures and options involve risk of loss and may not be suitable for everyone.

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